BusinessCorporate FinanceIAS39 regime will avert hedging calamities

IAS39 regime will avert hedging calamities

More rigorous accounting standard will benefit investors by making companies think through hedging deals

An IFRS specialist has defended the controversial IAS39 standard on complex
derivatives.

The new standard’s critics claim the rules on derivatives have made the
accounts of banks and insurance companies, among others, less transparent – the
opposite of its intentions.

But Johann Kruger, an IFRS specialist at Lloyds TSB, said that previous
standards had not reflected the full extent of the risks involved in hedges and
derivatives.

Kruger said that although IAS39 needed improvements – particularly in the
areas of retail price index-linked derivatives, derivatives used on other
derivatives and net investment hedges – its stricter regime would help prevent
hedging disasters.

Hedging calamities include Sumitomo’s $2.6bn (£1.48bn) loss on copper
derivatives trading in 1996, the $1.5bn damage to Metallgesellschaft from oil
futures in 1994, and Procter & Gamble’s $102m loss on an interest rate
derivative deal.

Before IFRS, boards could conceal such losses from investors because
standards did not require detailed disclosures on derivative liabilities. Under
IAS39 such cover-ups are almost impossible.

‘IAS39’s strict hedge accounting requirements force companies to document the
thought process behind hedging transactions in a disciplined fashion,’ said
Kruger. ‘Investors clearly benefit from such discipline.’

Under IAS39, companies have to provide detailed documentation explaining why
they are entering a hedged position and what underlying assets the hedge will
support. They must also demonstrate the hedge’s effectiveness at every reporting
date.

Under the previous standard, companies only had to tell auditors what hedges
they were using and why they should be accrued.

‘IAS39 forces you to think about what you are doing,’ Kruger said. ‘An FD
cannot sign off a hedge or a derivative without explaining the process to the
chief executive and the board.’

However, Ken Wild, head of IFRS at Deloitte, warned that stricter
documentation processes should not replace robust risk management.

‘The requirements of IAS39 are bureaucratic and the procedures focus on how
to record information rather than on risk management,’ he said. ‘The standard on
its own is not adequate for risk management in treasury departments.’

Kruger, however, said that IAS39 was consistent with tight corporate
governance procedures. ‘If applied consistently, IAS39 would signif-icantly
increase management’s understanding and ability to actively monitor the use of
derivative hedging instruments,’ he said.

Company reports

Man Group bids for bankrupt brokerage as BA prepares to grasp the
pension deficit nettle

FTSE100
Hedge fund manager Man Group has confirmed it has submitted a
bid for the assets of bankrupt US futures brokerage Refco, which collapsed
following the discovery of a $430m (£246.1m) black hole in its accounts. Other
groups believed to be interested in the Refco assets, which are being auctioned
off under the US bankruptcy process, include Interactive Brokers Group,
TradeLink and a consortium including Merrill Lynch, Warburg and Susquehanna.

British Airways, reporting an 8.2% increase in revenue to
£4.2bn, will discuss its pension deficit with trustees and unions in 2006 after
a period of consultation. The group’s pension deficit is one of the largest in
the UK. BA said: ‘Like most FTSE100 companies with defined benefit pension
schemes, British Airways has a significant deficit. We have launched a major
internal communication campaign to inform staff about the issues. This will
continue for several months.’

FTSE250
Announcing a 22% increase in pre-tax profits to £99m for the six months ended 30
September, Pilkington Glass said that it had reduced net debt
by 12%, from £775m to £685m. Over the past 12 months Pilkington has focused on
cash generation and achieving a strong free cash flow of £69m in the half-year.
The group is believed to be subject to a bid approach from Japan’s Nippon Sheet
Glass.

FTSEALL-SHARE
Roddy Murray, Moss Bros FD, has resigned after the group warned
that trading and like-for-like sales for the first 15 weeks of the second half
were flat against the previous year. Last month Moss said like-for-like sales
for the first 10 weeks of the second half were up 1.5%, but since then the group
has suffered from tough trading conditions.

AIM
Whitehead Mann, which reports interim results tomorrow, is set
to benefit from the raft of Sarbanes-Oxley and IFRS work. Accountancy has
provided substantial revenues for recruitment companies and investors will be
watching to see if the group has also benefited.

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